Each summer, the NHL gives way to a kind of theater of the absurd. During the annual free-agent feeding frenzy, more than a few general managers are a lock to commit obvious and egregious long-term, multi-million dollar errors when they “win” the auction for a big-name player. The spectacle was even more grotesque this season thanks to a number of wallet-punching buy-outs that were committed in anticipation. Object lessons in theory, pearls before swine in fact.

This is not, however, a brand of obstinacy or idiocy unique to the NHL—or even pro sports management. Since about the 1950’s, economists have known about the tendency for bidders to overvalue or overpay for assets in auction-type environments.

A common experiment held in economics classrooms: an auction wherein students bid on the number of pennies in a jar. Almost invariably, the winner will find out he has paid too much. Although some of the students’ bids are too low and some are about right, it’s the student who most overestimates the value of the coins in the jar who is obligated to pay for them; the worst forecaster takes the "prize."

This tendency is most obvious in cases where information about the asset is imperfect—like trying to estimate how many pennies are in a jar. Or, perhaps, like determining the impact of a single player in a team game. Of course, the winner's curse most frequently applies when there are a lot of bidders involved in the auction: it increases the chance that more than one bidder is overvaluing the asset.

Which is why, year after year, the July auction for the biggest available free agents inevitably gives rise to future buy-out candidate contracts. The worst forecaster—the GM who overestimates the player’s value the most—often wins the bidding.

Balancing risk

I was reminded on Twitter recently that signing long-term deals can actually reduce risks for teams; primarily, it guards against salary and cap hit inflation as revenues increase, or as a player’s relative value goes up. That’s why teams will sometimes do deals like the Nashville Predators' recent signing of Roman Josi (seven years, $4 million average). The longer term means that teams capture prime seasons and UFA years which would likely be much more expensive to buy in the future.

Although there is some risk attached to a deal involving a younger and somewhat unproven player like Josi, the bidding also wasn’t subject to the inflationary process that gives rise to the winner's curse, since Josi was both a restricted free agent (and therefore not necessarily open to the highest bidder) and not the sort of big-name asset that would result in a large bidding war.

Of course, risk-limiting factors in long-term contracts are quite frequently outstripped by other risk-promoting elements. For example, most high-demand UFAs are coming off some sort of peak performance level that is unlikely to persist. Not only do most NHLers tend to peak in their mid-20s, there is also a steep drop-off in terms of output after about the age of 35—assuming a player makes it to the plateau at all. In addition, many NHL GMs are apparently either ignorant or dismissive of factors like personal shooting percentage spikes or performance-inflating circumstantial factors (like zone starts or quality of competition), which can make accurately assessing a player’s current value a challenge (let alone forecasting years into the future).

There are also idiosyncratic risks that accumulate with the addition of more years on a contract. Specifically, the chance that some unforeseen personal factor or chronic injury will inhibit a player’s future performance, lowering his value.

On top of all that, big dollar, long-term deals are inherently risky because they can become toxic assets should a player’s perceived value dip significantly for any reason. This means that even good players in absolute terms become untradeable boat anchors if their contract is perceived as too much of a burden.

So in general, long-term contracts aren’t necessarily a bad bet. Unfortunately, the winner's curse, the fact that UFAs peak seasons are more likely in the past than the future and GMs' sometimes short shrift to factors that artificially inflate performance means they are frequently poor gambles.

Why do they do it?

Beyond the winner's curse, NHL GMs also are under more pressure to win now than later. Like politicians, incentives for NHL executives often flow counter to sober, long-term considerations. Spend the money now, land the player, improve your chances of winning in the present and defer risk to down the line to when somebody else may be running the show.

Incidentally, these are many of the reasons we frequently have owner-instigated lockouts in pro sports. The winner's curse and the natural tendency of GMs to foreground short-term gains over long-term risks results in ever-rising player costs in unfettered, “free market” type collective bargaining agreements. By building structure directly into the CBA itself, owners can not only put limits on the upward mobility of the players' share of revenues, but can also partially “police” the worst (and entirely human) habits of both their own and rival GMs.

Of course, absent a total ban on long-term deals and a socialist-style pay model where every player is compensated based on need rather than ability, every summer will bring big deals with many years and even more zeros attached. Until GMs can perfectly predict the future—or winning later means as much as winning now—there will always be at least one guy willing to commit too much for too long.

Kent Wilson is the editor in chief of The Nation Network, a Sporting News partner. Find his stuff at FlamesNation.ca and follow him on Twitter: @Kent_Wilson.